How ‘black money’ saved the Indian economy in 2008 crisis (and continues to save it..)

The presence of huge black money in housing is a well known fact but our experts choose to just ignore it. Infact what is so obvious, why talk about it?

Most homes involve paying a large % of home price as black money (unaccounted, in cash). The % varies from 20% to 30% depending on the value of the house, nature of transaction, eagerness of both parties to pay tax and so on. This means when the buyer goes to the bank for a loan, the price is already quoted lower at 70% – 80% of the actual price. Bank further gives loan at a maximum 80% of the loan value which comes to around 50-60% of the actual price. In case of a crisis in property market, the prices have to drop by more than 50% for the bank to go under.

Kaushik Basu, the chief economist of the World Bank and former chief economic adviser to the Indian government, says the nation’s tradition of petty corruption helped India avoid the worst of the banking crisis that has crippled most other large economies in the last few years. It is an extraordinary claim for such an influential figure to make but, as he says in his new book, An Economist in the Real World, “economics is not a moral subject”.

His argument is that the pervasive use of “black money” – illegal cash, hidden from the tax authorities – created a bulwark against a crisis in the banking sector.

Back in the last years of the noughties India’s economy was looking just as frothy as the rest of the world. It had been growing at an astounding 9% a year for the three years to 2008. What’s more, India’s growth had been fuelled, at least in part, by a dramatic housing boom. Between 2002 and 2006 average property prices increased by 16% a year, way ahead of average incomes, and faster even than in the US. The difference in India is that all this “irrational exuberance” did not end in disaster.

There was no subprime loans crisis to precipitate a wider crisis throughout the banking sector. So the big question is why not. There were some shrewd precautionary moves by India’s central bank, concedes Mr Basu, but he says one important answer is all that dirty money.

In most of the world the price you pay for a property is pretty much the price listed in the window of the local realtor or estate agent. Not in India.

Here a significant part of almost all house purchases are made in cash. And because the highest denomination note in India is 1,000 rupees, ($15; £10) it isn’t unusual for a buyer to turn up with – literally – a suitcase full of used notes.

This is how it works.

He then tells you the above example of connections between Indian housing and banking..

This is not just 2008, the practice continues and thrives as home prices only keep going up. All the talk of slowdown in home prices is just hogwash. In places where it shows prices have dropped, most likely cash component has one up..